Speaking Out

Questioning FAS 106 Proposals

The University's plans for compliance with Statement 106 of the
Financial Accounting Standards Board (FAS 106) raise a number of
questions and problems that I can best illustrate by quotations from the
two recent Almanac articles on the subject (see References below-readers
who have not yet read these carefully are strongly urged to do so). The
first section that specifically addresses FAS 106 at-tempts, reasonably
enough, to assess the magnitude of the problem caused by the requirement
to accrue the costs of post-retirement medical benefits over the work-
ing career of employees by assigning a number to it:

Penn's FAS 106 liability was approximately $96 million as of the
beginning of FY 1992.(1)

How this number was calculated is not made clear. The Vice President for
Human Resources volunteered at a meeting of the Medical Faculty Senate
that it had been obtained by outside accountants on the basis of various
employee profile data supplied to them by the University, but would say
little more about it. (Could we not calculate it ourselves, or were we
re-quired to obtain it from an independent source?) Maybe the following
sheds some light on its genesis:

... very few staff and even fewer faculty retire before the age of 65.
For FAS 106 purposes, however, this aspect of the program is very costly
because the University must recognize the potential that many
individuals will retire before age 65. (2)

Its characterization as a "liability" that "recognize(s) the potential"
of an admittedly unlikely event suggests to me that it has something of
the nature of a worst-case scenario. Does it assume that all employees
will retire as soon as they become eligible for retiree medical
benefits, in most cases at age 55? If yes, in what other respects is it
unrealistic? What figure represents a best estimate of the actual costs
of post-retire-ment medical benefits that would have been accrued by
employees at that time?

If, as I conjecture above, actual costs are likely to be
substantially less than the calculated liability, why does the FAS 106
Work Group recommend that the University fund the latter in full:

While FAS 106 requires an accounting recognition of post-retirement
medical benefits, it does not require an employer to fund the liability.
There are advantages in doing so however. (1)

Is this an all-or-nothing choice? The impact of funding only a
reasonable estimate of actual costs, or even a conservatively high one,
would surely be considerably less severe. Does the answer lie in:

The University could secure the needed monies through an increase in
allocated costs to schools and centers, through a reduction in their
subvention, or by increasing the employee benefits rate ... . The last
option offers the advantage of accelerating collection from third
parties, particularly Federal research sponsors... (1)

Clearly an incentive to the University for this approach is that it
could transfer a significant fraction of the burden from unrestricted
funds to restricted income, mainly Federal grants and contracts.

Many employers use early retirement programs as a cost saving tool,
since the net reduction in compensation expenses more than offsets the
additional benefits. Thus the calculated FAS 106 liability only presents one side of the picture: even if the University should for some
reason experience mass early retirements the overall cost to it would
be considerably less. The purely fiscal arguments for tinkering with the
retirement benefits, even those that affect "very few" individuals, seem
less than compelling.

The solution of increasing the employee benefits rate in order to
recover part of the inflated liability from restricted funds is
presented on the grounds of expedience, without any discussion of its
appropriateness or otherwise. Even in this light however, it has
negative consequences that ought to be considered--I will confine myself
to two such. The bulk of the unrestricted budgets of those departments
whose faculty research is largely grant-supported tends to be devoted
to compensation. In those cases an increase in the benefits rate of only
a few percentage points can represent a substantial portion of the
discretionary budget. Faculty whose grants have recently been renewed
for multi-year periods will also face a problem, since their budgets are
fixed in broad outline for that time. Likewise in their case too only
some small fraction of the total may represent funds that can be
reallocated without significant disruption.